4 ms·
$1000 worth of bonds at 2% simple interest rate returns $1200. The US 10 year treasury interest rate is 3.7% right now. That means you can get $1200 in 10 year
by barrkel 4y ago
$1000 worth of bonds at 2% simple interest rate returns $1200.
The US 10 year treasury interest rate is 3.7% right now. That means you can get $1200 in 10 years with $835 today at 3.7% compounding; 1200 / 1.037^10 = 834.44 and change.
So your $1000 worth of bonds is actually only worth about $835, at best, because that's the market price for a (close as possible to) risk-free investment which matches the return at maturity.
Inflation is the flip-side of this. You can reasonably expect $1200 in 10 years to be worth about what $835 is today. It might be less, it might be more, but it's an estimation with money behind it.
- mcv 4y ago> risk-free investment That's what I don't get. Why are bonds considered risk free if their value can drop when interest rates go up? Sure, they may be worth $1200 in 10 years, but they're only worth $835 now, when they were worth $1000 yesterday. Risk may be lower than buying shares in a company at risk of bankruptcy, but it's hardly risk free. These things can go up and down just like normal share prices.
- jkhdigital 4y agoThere’s no default risk, that’s all. “Risk-free” only refers to the risk of default. Every (fixed-rate) debt instrument has unavoidable interest rate risk. And the floating rate ones are just transmuting it into default risk.
- xmcqdpt2 4y agoYou are correct, these are two different kind of risks. The "risk-free" rate refers to counterparty risk (which should be zero when the counterparty has the money printer, or can be bailed out by the money printer.)